Cost Accounting Chapter 11

Decision Models

a formal method of making a choice, and can include qualitative as well as quantitative analysis

5 step process for decision-making

1. Obtain information
2. Make predictions about future costs
3. Choose and alternative
4. Implement the decision
5. Evaluate performance

decision making enhanced when:

relevant costs and revenues are distinguished from irrelevant cost and revenues

Relevant Information

1. it occurs in the future
2. it differs among the alternative courses of action

Relevant costs

expected future costs

Relevant Revenues

expected future revenues

Sunk costs

- costs that have already occurred and cannot be changed by future actions
- costs incurred in past and non-refundable
- may be helpful for predictions but are ALWAYS IRRELEVANT when making decisions

expected future revenues and costs that DO NOT differ among alternatives are:

Irrelevant and eliminated from the analysis

Key Question=

What difference will an action make?

Quantitative= #

includes financial and non-financial measures
quantitative factor may be direct material cost, direct labor dollars, or number of units produced

Qualitative = NO #

difficult to measure in numerical terms
employee morale and prestige

Incremental cost

additional total cost incurred for an activity

Incremental Revenue

additional total revenue from an activity

Differential cost

the difference in total cot between two alternatives

Differential Revenue

the difference in total revenue between two alternatives

keys in analyzing short-term special business decisions

focus on relevant revenues, cost and profits
use contribution margin approach that separates variable cost form fixed costs

special order

occurs when a customer requests a one-time order at a reduced sales price
often large quantities

Before agreeing, mgmt must consider:

1. if it has excess capacity- if the company is already making as many units as possible at regular sales price a special order wouldn't make sense
2. if special sales price is high enough to cover incremental costs of filling the order
sales price>variab

Decision Rule

Do we have excess capacity available to fill this order

Incremental analysis approach

leave out irrelevant info
analyze fixed and variable costs separately
CM income statements are bests

Outsourcing (Make or Buy)

buy a product or make it
heart of the decision= how best to use available resources
look at fixed costs that can't be avoided even if you buy rather than make

Should company outsource?

if incremental costs of making> incremental cost of outsourcing = Outsource
if incremental cost of making< incremental cost of outsourcing = Make

Product-mix

manufacturer=constraint often in labor hours
merchandiser= constraint = cubic feet of display space
***Emphasize the product with the highest CM/unit of constraint

Customer Profitability

Decsion rule: does adding or dropping a customer add operating income to the firm?
based on PROFITABILITY of customer not how much revenue a customer generates

Add/Drop product line

Focus on relevant data
use CM margin approach
if line provides positive CM, keep or add
negative CM = drop
based on PROFITABILITY of line not how much revenue a line generates

Equipment Replacement

Irrelevant info:
Cost, accumulated depreciation, book value of existing equipment
any potential gain/loss from transaction

Which of the following should NOT be considered for every option in the decision process?

Historical costs

What is always the question to ask to determine if revenues or costs are relevant

what difference will an action make?

The concept of outsourcing services to countries with lower labor cost is known as

international outsourcing

which of the following is NOT a correct use of the term opportunity cost?

Opportunity costs are considered period costs rather than inventoriable costs for accounting production

What is the key question a company should ask when deciding whether to keep or drop a particular customer?

Will expected total corporate office costs decrease if decision is made to drop the customer?

Which of the following is NOT a reason for the performance evaluation model to differ from the decision model

the accounting systems enable each decision to be tracked separately

T/F? Opportunity cost is the contribution to operating income that is forgone by NOT using a limited resource in its next-best alternative use

True

T/F? When there is a constraining resource, the firm should attempt to maximize sales of the product or service with the greatest contribution margin per unit

False

T/F? Avoidable variable and fixed costs should be evaluated when deciding whether to discontinue a product

True

T/F? When replacing an old machine with a new machine, the trade in value of the old machine is relevant

True